In fact, that re-rating looks as if it is starting to happen right now because, with the company's share price closing in on a 55p high dating back to January 2013, a major break-out is on the cards. Indeed, from a technical perspective, there is no price resistance whatsoever until the price hits 80p, a resistance level dating back to 2008, thus offering scope for quite a dramatic re-rating. Beyond that, the 100p highs dating back to before the 2007-08 financial crisis are not unrealistic medium-term targets, too.
True, the 14-day relative strength indicator (RSI) is becoming overbought, but this can easily unwind itself in a sideways share price move and I am pretty confident that if the share price does break above 55p, then it will be the real deal and the buy signal should be followed.
Hefty returns from syndicated corporate loans
The company that offers this tantalising mix is small-cap specialist finance company GLI Finance (GLIF: 53.25p), a business that is capitalised at around £75m.
What sparked my interest was news last November that the company was changing its investment strategy. To date, GLI has principally invested in syndicated corporate loans issued primarily by mid-market companies, but with particular focus on the US and the UK. These so-called collateralised debt obligations, or CLOs, are a form of securitisation where payments from multiple middle-sized and large business loans are pooled together and passed on to different classes of owners in various tranches. As we know now, during the boom years in the run up to the 2008 financial crisis, global investment banks were abusing the system and creating poor quality CLOs that were being sold onto investors as higher credit-worthy investments. As a result, secondary market demand for these investments collapsed in the dark days of 2008 and 2009, and with investor demand drying up, prices plunged, too.
But with markets stabilising and demand for CLOs improving in recent years, there is now a ready market in this form of investment finance, which is why the current directors of GLI believe that spinning off their portfolio of investments now can realise value for shareholders. The senior loan market has seen good recovery rates, according to ratings agency Moody's. Indeed, over the past couple of decades, defaulting bank loans experienced average recovery rates of around 80 per cent compared with just 45 per cent for senior unsecured bonds and 30 per cent for senior subordinated bonds source. Credit quality for the core US senior loan market that GLI Finance operates in has been too good in that spreads have been contracting and loans are being repaid early by corporations. Hence, this is an opportune time to spin off the CLO interests into a separate entity. It's worth noting that GLI has been able to achieve superior investment returns in its core US mid-corporate debt holdings by identifying where the market has wrongly assessed default risk or where discounts embedded in valuations for illiquidity, sentiment or bid-offer discounts are simply too wide. Moreover, the middle market is less well covered and is under-researched compared to major corporate debt, creating more opportunities for GLI to seek out mispriced investments and enabling it to generate excellent long-term returns.
This explains why the company can afford to pay a 1.25p a share quarterly dividend from the high returns it makes on the debt obligations it holds. In fact, analysts at investment research house Edison predict that GLI will make adjusted pre-tax profits of £6.6m on revenues of £15.8m in 2013 to produce EPS of 5.38p. The December 2013 year-end book value of the company was 50p, so the shares are trading in line with the underlying value of the investment holdings.
For the current financial year, the estimates are for revenues of £16.1m, pre-tax profits of £7.6m, EPS of 5.74p and a raised dividend of 5.25p. On this basis, GLI shares trade on less than 10 times earnings estimates and offer a forward dividend yield of 10 per cent.
Peer-to-peer and SME lending
The upside in the shares from the forthcoming spin-off of the CLO investments into an Aim-traded listed entity aside, GLI has been increasing its exposure to the peer-to-peer lending sector and to small- and medium-sized enterprise (SME) finance in the UK, Europe and the US. This will form the core of the business in the future. So far the company has made seven interesting investments.
These include a £800,000 equity investment in TradeRiver Finance, an online trade finance business that has provided funding on over 500 transactions worth around £24m since being established in 2009. GLI is also providing a £2m credit line to TradeRiver. The business provides funding for up to 120 days to sellers of goods which have annual turnover of between £5m to £500m. Credit limits range between £100,000 and £750,000.
GLI has also invested £1.25m for a 75 per cent stake in a new UK joint venture with CRX, the owner of Finpoint, a business-to-business platform enabling institutional investors to buy loans directly from SMEs. Finpoint has been operating for three years in Germany where it has completed on more than 100 loans totalling €340m. The platform enables the borrower to gain access to multiple lenders across a number of funding lines, including factoring, invoice discounting and secured loans. Borrowers pay a fee of £499 plus VAT and income is also generated from lenders.
Another interesting investment is in Proplend, a UK secured peer-to-peer lender offering secured commercial loans on property. GLI has invested £1m for a 22.5 per cent stake (equity and preference shares) in the operation which started trading in the first quarter of this year. Loans have a duration of between six months and five years and for between £500,000 and £5m, secured on pre-owned commercial property. Lending on that scale is significantly higher than current peer-to-peer platforms, so offering a largely untapped market to service the needs of non-bank borrowers. The business goes online at the end of next month.
GLI's other investments include a 30 per cent stake in Raiseworks, a US peer-to-peer SME lending provider for the small business sector. Raiseworks has spent the past two years building the platform, developing the credit underwriting model, establishing partnerships, and securing a broker dealer license. First loans are expected to be made either in the second or third quarter this year, attracting interest rates of between six and 20 per cent and having a maturity of one to five years. Raiseworks will earn its income from the borrower through listing, completion and a loan servicing fees.
Realising value
The end game for these peer-to-peer investments GLI is making will either be a trade sale of the business once it has gained scale and profitability, or a stock market float. It's a growing market place and one that analysts have estimated will be worth £12.3bn within the next 10 years. Current market leaders are Funding Circle and Zopa, but it's only reasonable to expect further new entrants given the UK banking sector's unwillingness to provide funding for small businesses.
It's also why buying shares in GLI makes a lot of sense given the company has the funding in place to do further deals in this niche area and one which should offer potential to generate significant returns for shareholders. To put the growth potential into some perspective, Funding Circle has originated over £200m of loans with in excess of 65,000 investors since launch in 2010.
And the best part of it is that with shares in GLI trading more or less in line with book value, the exposure to its investments in peer-to-peer lenders is in the price for free since the CLO operation, producing that bumper dividend, is worth the current share price alone. We are also guaranteed yet more positive newsflow as more partnerships are entered into.
Of course, there are risks to GLI's new strategy and credit losses is the most obvious one if lending procedures are not rigorous enough. Also, we will have to wait and see how popular peer-to-peer lending proves when interest rates start to rise again, or if alternative rates of return elsewhere prove more attractive to income-hungry investors seeking a home for their capital. It's only fair to flag up that liquidity on these new platforms may prove an issue in matching borrowers with lenders. Furthermore, because crowd lending has only become popular post the 2008-09 recession, we have yet to see how resilient it will prove to be in a sharp economic slowdown. But, ultimately, the greatest risk to new entrants is that banks will loosen their purse strings and start ramping up lending to SMEs, as unlikely as it seems at present.
That said, and taking all these risk factors into consideration, I still believe there is significant upside to the shares of GLI.
Target price
Having appraised the fundamental case for investing, and taken the technical set-up into consideration, I feel fair value on GLI shares is around 80p, or 50 per cent above the current share price. At this level, the 2014 prospective dividend yield would still be 6.5 per cent. And, as I alluded to at the start of this article, clearly the directors are confident of share price upside, too.
For instance, at the end of January, chief executive Geoff Millar purchased 50,000 shares at 50.44p to take his holding to 1.57m, or 1.12 per cent of the share capital; director James Carthew acquired 35,000 shares at the same price to take his holding to 235,000 shares; new finance director Emma Stubbs made a maiden purchase of 20,000 shares at the same price; and chairman Patrick Firth purchased a further 75,000 shares at 50.5p each to take his holding to 209,000 shares.
In my opinion, it's well worth following the insiders' lead, and ahead of the full-year results due out next month, I rate shares in GLI Finance a buy on a bid offer spread of 52.5p to 53.25p.
